Thursday, September 29, 2011

China's Overreliance On Government Directed Investment

China's property bubble is set to burst, causing greater damage to the domestic economy than the U.S. suffered after its housing market collapsed in 2008, a government economist warned in comments published Friday. Yi Xianrong, a researcher at the Chinese Academy of Social Sciences with a reputation for speaking out against the government's housing policy, said the U.S. housing bubble was smaller than China's and still burst, despite the country's superior legal and credit systems. _SeekingAlpha

China’s problem, however, is that most of this investment is state-directed and this means China’s investment expansion is arguably more likely to create a financial bubble and be less productive than that of the US, Germany et al before it. Again, past is prologue. Both Korea and Japan’s investment spree ended with a bubble bursting – Korea’s in the Asian financial crisis in 1997 and Japan’s in 1990. _FT

Read both of the articles above in their entirety, for a balanced view of China's predicament.

When China's export markets collapsed in 2008, the CCP government turned to local infrastructure spending to maintain employment and GDP growth. But much of the spending and construction occurred on the basis of government direction, rather than in response to the needs of any market. This type of central economic planning led to the collapse of the old USSR, and is leading to chronic creeping poverty in Cuba, North Korea, and increasingly in Venezuela.

China's regional governments are going further and further out on an economic limb to finance projects which may look good on the balance sheets, but which will not provide enough return to pay back the loans which were extended to finance them. The famous "ghost cities," "ghost shopping malls," "ghost trade centres," and such are but the tip of the iceberg.

When this widespread overextension of banks, governments, state-owned enterprises, and politically well-connected enterprises becomes stressed sufficiently, the painful effects of this misallocation of capital and the "Potemkin economy" will be more difficult to hide.